You do not increase spending by cutting it

Last weekend, on the eve of the G-20 meeting in Paris over the weekend, the Australian Treasurer was talking tough and giving ultimatums to our Northern friends – telling them that the “time for half measures is over. The time for action is here. So people will be looking for a comprehensive plan on October 23″. Of-course, in the Communiqué of Finance Ministers and Central Bank Governors of the G20 from the Paris meeting you don’t get any sense of urgency. Not once do they mention the word “unemployment”. The problem is that the world leaders remain in denial and still want us to believe that you can have “growth-friendly” cuts in spending. To increase spending you do not cut it.
The following graph uses the ECB data for 10 year bond rates (and I have expressed them in terms of the spread against the German benchmark bond). You can see that while the usual suspects are pointing higher and more quickly (Greece, Ireland, Portugal) the bond markets are now moving to Italy, Belgium, Austria and France.

Thanks to half-baked rescue plans and barely disguised renunciations, the eurozone is daily slipping into a core meltdown process. This sort of crisis has nothing to do with a nuclear plant’s core reactor, but the slow deterioration of Europe’s core, as the relentless wave of investor distrust toward government bonds, which has already put Greece, Ireland and Portugal underwater and seriously doused Italy and Spain, begins to pull down Belgium and threatens France, with Austria next in line … The core under attack!

We are no longer talking about just “peripheral” nations. The relentless process on eurozone sovereign debt markets can be plainly seen, following the first crisis of May-June 2010, after which the first Greek bailout plan was launched and the ECB intervened directly to calm secondary markets via its Securities Market Program (SMP).

A salutary observation.

The days of blaming the lazy, profligate or whatever other insulting description for the peripheral nations that the Germans can muster – are over.

The spreads are widening for the northern EMU economies now. You may argue that they widened across the EMU in late 2008 into 2009 and corrected again. Erwan Mahe says that this was time when “certain spreads widened due to a total absence of liquidity on financial markets. But even then, France’s spread vis-à-vis Germany amounted to just 60 bps, which compares with over 107 bps today. The spread hasn’t been this wide since 1992! That shows just how much ground we have lost”.

The Guardian reported that “Germany’s finance minister, Wolfgang Schäuble, added to the uncertainty earlier in the day when he said detailed talks to solve the crisis were likely to go beyond a self-imposed deadline set for this weekend”.

All the talk has been that this time – after many failed attempts – the EU leaders would bring out the “big bazooka” which would ease the concern of the bond markets. The German finance minister downplayed that reality.

The Guardian said that his comments “dismayed investors concerned that Berlin and Paris have failed to grasp the magnitude of the eurozone’s debt crisis”.

In a sense, what the graph is depicting (that is, what the “dismayed investors” aka the bond markets are thinking) is not a definitive description of the crisis. The reality is that the bond markets can be played out of the game if the ECB maintains its support for each of the nations that are now finding it hard to fund themselves at reasonable rates in the private markets.

As Erwan Mahe says:

The two big peripheral nation markets, Spain and Italy, are already breathing via an artificial lung, and the ECB bond purchase programme is the only thing preventing death, while Belgium is pretty close to joining them.

And as long as the EU leaders dally around at their summits drinking fine wine and eating well but not doing very much else the ECB will have to continue in that role.

The ideas surrounding a new bailout fund where the EU members contribute directly to the scheme will not solve the problem. That plan will just further drain economies that desperately need all the government support they can get.

The EU Communique´ is just more of the same – hot air and little else.

You will read lots of “We are more determined than ever to reform the financial sector” and “We reaffirmed our shared interest in a strong and stable international financial system” and “We remain committed to take all necessary actions to preserve the stability of banking systems and financial markets” but not a single mention of unemployment and poverty.

The national treasurers and central bankers of the larger economies – entrusted to design and implement fiscal and monetary policy – at a time when the global economy is slowing and has been stagnating for nearly 4 years – and they cannot mention the word unemployment once. That is a statement of what is wrong.

In advanced G-20 economies, fiscal sustainability must be restored through credible medium-term consolidation plans. Countries with high debt and facing market pressure must press ahead with “growth-friendly” consolidation now. In others, fiscal policy should navigate between the perils of undermining credibility and undercutting recovery, and facilitate a pick-up in private demand. To alleviate prevailing market pressures in the euro area, the ECB should continue its extended liquidity operations and sustain the Securities Market Program (SMP) alongside the support provided by the European Financial Stability Facility (EFSF) for as long as necessary to stabilize issuance costs for banks and sovereigns.

I love the terminology that has crept into the IMF papers lately – “growth-friendly” consolidation – what the hell does that mean? Answer: nothing. They just cannot bear to admit that the only way out is for economic growth to quicken yet fiscal austerity will undermine that.

Fiscal consolidation to the IMF is fiscal austerity. It means discretionary cuts to public spending and/or tax hikes (although the IMF tends to frown on the latter). Any discretionary attempt to reduce net public spending (deficits) in the advanced economies will reduce growth.

There is no such things as “growth-friendly” consolidation.

Note also that they are not pushing the Ricardian Equivalence line strongly. In the past they have claimed that the private sector will pick up the spending slack left by the public austerity. Ricardian Equivalence refers to the notion (loosely) that households and firms are deliberately refraining from spending as much as they might at present because they sense the deficits will have to be paid back via higher future taxes and so are saving to make sure they can pay those taxes. It is a nonsensical mainstream proposition.

This concept has been used to justify the British government’s austerity program. The overwhelming evidence negates the validity of the concept. Private spending is flat because people are scared of unemployment, they are trying to pay down debt after the credit-binge, and firms are experiencing poor sales and so have no incentive to create new productive capacity.

You will note that the IMF is also still claiming that there is a credibility problem in the advanced world with respect to budget deficits. If you tease that out a bit what they are implying is that there is trade-off between credibility (that is, what the bond markets think) and growth (that is, what matters to the 99 per cent of us).

But they then acknowledge in the next sentence that the ECB can “alleviate prevailing market pressures in the euro area” by funding the governments directly. So what does credibility in the eyes of the bond markets have to do with anything? If the central bank (and/or treasury) can deal the bond markets out of the equation then the notion of credibility becomes non-operational.

The ECB’s actions do not alleviate the design flaws in the EMU but they do serve as a quasi-fiscal authority. The problem with the way the ECB is acting is that they are insisting that the member nations deflate demand in their economies and kill jobs and growth in return for this “fiscal” support. All that means is that they will have to continue to provide the support indefinitely while poverty rates rise across Europe with the entrenched unemployment.

The ECB would be far smarter to encourage member nations to stimulate growth and build private confidence so that within that security screen public deficits would fall and the “funding” needs would also decline.

But the real problem is not the rising interest-rate spreads – they are just the symptom (reflecting the institutional arrangements) of the underlying crisis – a failure to grow and produce jobs. Which is a reflection of a lack of aggregate demand.

The IMF realises that very clearly – but, of-course, temper their statements with their neo-liberal mantra. But nothing could be clearer than their statement of the “Key Risks”:

Downside risks have increased and are severe. The overarching risk is of a global “paradox of thrift” as households, firms, and governments around the world reduce demand, with many advanced economies unable to lower policy rates further. Immediate risks are centered in the major advanced G-20 economies, principally the euro area and the United States.

That is a most Keynesian message. Spending creates income which creates growth which creates employment.

If everyone is trying to cut spending or not spending enough then the rest of the causal train suffers. The austerity of one spending groups affects the next and the deflationary snowball multiplies.

You can see the inherent bias in the IMF statement though – “with many advanced economies unable to lower policy rates further”. This refers to their bias towards monetary policy as the principle source of stimulus.

One of the major lessons of this crisis (among many) is that monetary policy cannot stimulate aggregate demand very much at all. Try as they might – with all the QE schemes etc – and clearly being able to maintain low interest rates along the yield curve – the central banks have not been able to provide the stimulus to aggregate demand that is needed.

Conversely – it is clear that fiscal policy did provide a boost to growth in 2009-10 – but was shut-down too early because the likes of the IMF claimed the fiscal activism would lead to excessive interest rates and accelerating inflation. Neither has happened (notwithstanding the rise in inflation in the UK – which is a separate issue that I will consider in another blog).

The best the IMF can do with respect to “growth friendly” consolidation is this:

Credible medium-term fiscal plans, which would create space for providing further support for fledgling recovery, and well calibrated and appropriately paced fiscal adjustment in the near term to anchor investor confidence. This need to be supported by rapid implementation of structural reforms to raise growth and enhance debt sustainability

Note they are using the term “investor” here in the financial literature sense – that is, bond markets. An economist does not consider bond purchases or sales to be investment or divestment.

For an economist, investment is about adding to productive infrastructure – that is building equipment, plant etc – which increases in the capacity of the economy to produce real output.

The only credible “medium-term fiscal plans” is to ensure that growth wipes out the cyclical deficit component. I have seen no coherent analysis that suggests that structural deficits (the non-cyclical component) should also be wiped out.

The IMF note that the private debt burdens a large and dragging down growth – as households and firms try to reduce these debt positions. There is an urgent need for the private sector to save overall and get its balance sheet in a position where it can resume spending growth without the reliance on excessive credit.

That requires support from the government sector in the form of deficits.

The IMF provides some more:

Advanced G-20 economies must articulate credible medium-term fiscal consolidation plans with specific measures embedded in a realistic macroeconomic framework. This would create more policy space for near-term support to growth and employment if needed.

The advanced G-20 economies (outside the EMU) have all the policy space they need to support growth and employment. What they lack is the political will. There is no financial constraint on these governments. Their dysfunctional polities have created the situation where each thinks they have to cut net spending.

Even if you consider the reaction of bond markets, yields are low and the markets cannot get enough of public debt. The credibility issue is a “beat up” and reflect ideology rather than analytical nous.

The situation is different in the EMU because without ECB support the member nations can easily (and will) go broke. So without the ECB intervention, the bond markets have traction. In the other advanced nations the bond markets do not have the same traction.

But as I noted at the outset, central banks everywhere (including the EMU) can negate the actions of the private bond markets anytime they choose. That is exactly what the ECB is doing at present.

Conclusion

The real problem is a lack of demand which is causing growth to stagnate and unemployment and poverty to rise. All the meetings of the G-20 together will not solve anything while they refuse to deal with the fundamental cause of the problem.

If they really want to do something productive they should announce that they will use the central banks around the world to deal the bond markets out of the game and fund fiscal stimulus directly with a focus on job creation.

Putting wages back into the pockets of the unemployed is the surest way to get the growth process going again. Waiting for the private sector to miraculously start spending more at present is not going to work. The credit-binge has left too much private debt and saving ratios are returning to more normal levels now – which means that public net spending positions will have to return to more normal levels.

And historically, that means budget deficits will have to be maintained more or less continuously for the indefinite future. The leaders of the advanced world are doing us all a dis-service by acting in denial of that history.

They are not only fuelling the bond market reactions (as captured in the spread graph above) by pretending there is a “sovereign debt” crisis but by deliberately reducing economic growth they are also frustrating the private sector attempt to consolidate its balance sheet.

If fiscal support is provided the private sector can consolidate (reduce its debt exposure) and start to spend more (from growing wage income). That is the only way out of this mess and that will take some years at least.

I am heading to Melbourne today to be part of a panel at a workshop – Euro crisis – held by the Monash University EU Centre.

I will report back on the discussions tomorrow. And, yes, I am sorry – it means more air travel.

Would it be possible for each country to reintroduce national currencies alongside the euro gradually establishing exchange rates with the soon to be ex currency which would eventually morph into the Mark?

“Lord Wolfson offers £250K for the best idea in how to wind up the euro.”

There is no need to wind up the euro?

The ECB can remove the toxic assets from the market the same way the the Fed did in the USA. It can buy all of the Greek debt and put it on their balance sheet and take it off the banks. They don’t have to print money to pay for it. They can pay for it by issuing bank bills that count as bank’s capital but not as monetary reserves. With the ECB holding the debt bank’s do not need to recapitalise.

“Would it be possible for each country to reintroduce national currencies alongside the euro gradually establishing exchange rates with the soon to be ex currency which would eventually morph into the Mark?”

It’s dead simple. The country in question stops taking Euros in payment of taxes and starts requiring its own Bonds instead which it simply redenominates the face value in the new currency. New bonds are then issued in the new currency and of course cash is simply an infinite life 0% bearer bond.

That shunts the Euro to a parallel currency which then starts to float against the new currency, and since there are mechanisms in place already to buy the country’s bonds the banks can quickly change things across (and initially issue ‘tax payment’ services).

There is a slight problem with the phrase “fiscal consolidation” which looms large in the IMF’s “Path from Crisis to Recovery” document: the OECD’s definition of the term is completely different from the Financial Times’s definition! The former’s definition specifically does NOT include the eliminaton of fiscal debt, whereas the latter’s does.

But hey, if you’re being paid good money to produce hot air for the IMF, why bother with annoying little trifles like intellectual rigour, precision or accuracy?

The new currency would have to be printed. This can’t be done in secret. While it is being printed, there may be massive capital flight. In Argentina, there were still many pesos around. How do countries like Greece reintroduce their former currencies while avoiding massive outflow of euros to foreign banks. That seems to me the central question. Maybe the solution lies in a temporary prohibition on all transfers and severe limits on cash withdrawals. Some disruption is very likely because the new currency will have less value than the old.

I’ve been following your blog, and MMT, for a little while now, and it’s fascinating stuff.

I’m fairly green when it comes to economics, I’m ill-equipped to judge whether critiques of MMT are well-founded. I ran across the following critique of MMT (and you specifically) from a comment on your recent Harvard article. The website at which this criticism (and others) can be found is: http://www.zerohedge.com/contributed/mmt-and-munis.

The (incredibly rude) criticism, as posted by Dan Duncan, is as follows:

“Billy Mitchell…derives his justification from ‘The Fiscal Accounting Equation’. In this equation, he matches up ‘Sources of GDP’ = ‘Uses of GDP’. From there, he employs simple algebraic maniuplations to arrive at his ultimate conclusions…and the Holy Grail of MMT: http://moslereconomics.com/2010/04/30/tea-party-protest-sign/
The only problem, of course, is that Billy Mitchell doesn’t understand simple math (or logic).
The issue is not that Sources of GDP = Uses of GDP. Rather, it’s that Sources of GDP cause (or allow for) Uses of GDP. Once this is understood, his pathetic algebraic manipulations descend into a nightmare of recursive circular reference.
Yes, once the books are closed, then Sources=Uses. But at this point, all you accomplish by moving the terms around is to make a statement about what already happened….You cannot, however, move the terms around to affect policy. It’s too late for that.
Think of it this way: You own a business and run a household. Sales – CGS —>Mtg pymt+Groceries+Savings. Yes, at the end of the year, the LHS will = the RHS. But this does not mean we can move Savings over to the LHS of the equation and Sales over to the RHS. The Savings aspect was determined–in part–by Sales. We need to close the books, see what Sales actually were before we really know what the Savings were. Until the books are closed, Savings is really in a Schrodinger state of superposition.
If a+b causes x+y, you cannot just move the terms around. It’s not that simple. Yet, this is exactly what Billy Mitchell and the other MMT Morons do, when they attempt to justify this abomination.
Look at the Billy Mitchell explanation. I’m not making any of this up. It really is quite astonishing that MMT is taken seriously.”

As I said, I’m an economics amateur. How would you respond to the argument raised in this quote? Thanks in advance, and thank you for the great blog!

This person (Dan Duncan) clearly hasn’t read any of my work which repeatedly says that the sectoral balances of the National Accounts have to hold at each point in time (being relationships between flows) and it is national income movements which ensure that. The interesting thing is then what drives these national income movements and whether government action (discretionary) can influence the non-government aggregates. We know that non-government action influences the budget balance (via the automatic stabilisers). MMT also considers that government spending and taxation influences aggregate demand and hence aggregate output which influences private saving, imports and through accelerator effects private investment.http://bilbo.economicoutlook.net/blog/wp-admin/edit-comments.php#comments-form

I don’t think the critic has read any of that work otherwise he wouldn’t take that angle of attack. We (myself or my other MMT Morons) clearly understand that behaviour has to drive the accounting. The sectoral balances provide a useful check to ensure that goals are compatible. I think MMT is safe from the likes of Dan Duncan.

As an aside, the macroeconomics literature – mainstream or not – do not call the sectoral balances a “Fiscal Accounting Equation”. Using that terminology is not conventional and suggests that Dan Duncan is not very familiar with standard macroeconomics literary conventions. If you search Google for that term you will not yield anything about National Income accounting.

If you’re hoping for the ECB to see the light, don’t hold your breath. I was on a city break to Frankfurt last weekend (nice place, by the way), and being the fun-loving guy I am, went to the Geldmuseum, located on the outskirts of the city centre. Ostensibly, this place is a museum dedicated to explaining the roots and uses of money and currencies. The first half of the exhibition is very interesting and very well-presented, documenting the origins of money and showing the various specie throughout the ages. There’s even a rather entertaining exhibit of counterfeit notes and coins.

However, the second half of the exhibition is a tour de force of blatant propaganda – a terrible short film depicting an old woman travelling on a train opposite two bright young things who explain the wonders of the single currency to her, ending with her being delighted that we won’t have ‘the same problems as before’ (the old woman is German – I wonder what she’s talking about!!!!); then there’s an exhibition dedicated to telling us about the origins of the Bundesbank, stating bluntly that the central bank needed to be kept ‘independent’ from ‘interference’ by democratically-elected governments; finally, there’s another film, with an avuncular old German man who’s seen it all in his lifetime apparently, explaining the German economic miracle (it was all exports!), and getting disturbingly excited at the creation of the euro, all the time warning about inflation, and the need to treat unemployment as being ‘like a fever – it’s a symptom, not the illness’! The lovely old German chap then tells us that as long as the labour force remains ‘flexible’, we can look forward to a utopian inflation-free future!

The German financial authorities’ obsession with inflation, as far as I can see, is akin to the Irish Government warning all and sundry about potato blight.

Oh, I forgot to mention, there’s an exhibit paying homage to the Quantity Theory of Money, with a series of biographies of various Mont Pelerin types treated as though they had developed the polio vaccine. There’s even a bust of Milton Friedman there – say no more.

That was when I decided to make my exit, but not before I stopped by the gift shop, where I handed over €3.95 for a jar containing – wait for it – one thousand euros’ worth of shredded notes. They also have ‘bricks’ of shredded euros for sale, worth about a quarter of a million. I think I should write to M. Trichet, and let him know where some of our precious finite currency has disappeared to.

Bill you view on China being able to bail out its economy is correct but I think you overrate the Chinese and your view is very consensus and not priced into asset markets, a Chinese slowdown similiar to 2008 -2009 would be an economic disaster for Australian and New Zealand given thier greater operating leverage to China especially if it is combined with a US and European recession.
Australians terms of trade are over 3.s.d above the mean. Over history when the terms of trade have been over 2 s.d above the mean, typically a surprise shock sees them reverse sharply.

Anyway enjoy you blog but feel you are too optimistic on the Chinese ability espescially given the one child policy will ensure they get old before they get rich.

Bill and Brian,
.
Regarding Dan Duncan, I wonder if he has stumbled upon another means to get to the same ultimate conclusion that govt spending is necessary when other aspects of the economy are pulling in their horns?
.
Dan seems to grasp GDP(sources) = GDP(uses). And unless he’s willing to throw out “for every willing seller, a willing buyer” and only have one line (S) drawn on the Econ 10 demand-supply graph, I think he would also accept that C (source) = C (uses). That leaves us with I + G + (X – M) on the “sources” side and S+T on the uses side. We should be able to still write the resulting simplified equality as I+G+(X-M) = S+T for we do not violate his sacred cause-and-effect.
.
What this equation suggests is that if you are running a trade deficit and at the same time not building capital stock and inventories on the “source” side, then the only source capable of providing the “use” side (i.e., for savings and tax paying) is government spending.
.
I think if one was persistently real gentle with Dan, you might be able to get him to move the “T” over from the “use” side to the “source” side (something along the line of a “death and taxes” argument). That would simplify the equation further to show that when you have a trade deficit and not building capital stock, the only source for providing for savings on the “use side” is federal deficit spending.
.
With that would he be very far from grasping MMT?

As a follow-up, there is an interesting aspect to Dan’s reaction. And I don’t mean to pick on Dan specifically – he is just representative of an often-typical response to MMT and thereby more generally instructive.
.
What I find most interesting, if not the source of my concern for my nation, is the reaction to MMT displayed but those smart enough to at least know how to turn on a computer. I don’t want to denigrate the professional-level of MMT economists for I realize that any element of the field has deep rabbit holes that one can use to process through likely countless PhD thesis in exploration. But really, on at least the surface level that Dan is engaging in, this is not rocket science. So first, why the cognitive dissonance of Dan and the many others that come in contact with MMT’s pretty straight-forward descriptive elements?
.
The other aspect of the too-often reaction to MMT is, as it was with Dan, the quick vitriol that comes. I think you would be hard press to find anyone who has posted a description or defense of MMT tenets that hasn’t run into massive argumentum ad hominem.
.
One often finds that those most heated in the discourse of political exchanges (often to the point of attempting to dehumanize their viewed opponent) do indeed have some unrelated deep-seated anger now misdirected at a substitute, e.g. abuse in childhood that now gets directed to any expression of the necessity of centralized authority as a substitute for the abusing parent. Given that the substitution can never offer real resolution, the anger can never be satisfied and as such becomes both more quickly displayed and amplified. While I believe this is a feasible explanation for some of the vitriol, I just can’t see it as being the typical case – or at least that is my hope; and if it is the source of Dan’s angst, then I can only wish him the best.
.
Instead, I believe the prevalence of cognitive dissonance and near-immediate vitriol in the reactions by the many coming into contact with MMT’s tenets is something more generalized. I believe that the more-generalized underlying cause is memento mori, the fear of one’s inevitable death. We humans are the only species capable of recognizing that we have no choice but to die – this can be a good thing, but it also messes with our heads. There are many good pragmatic reasons to be the good child, the good provider, the good nurturer, neighbor, soldier, etc., but any one of these, if you can scratch deep enough below the surface, leads to a complex human construct of the world that if one behaves well within that ‘known’ construct one has a shot at deceiving death. The big downside is when those constructs, those views of how the world works, is threatened by a “non-believer” even if that non-believer comes bearing irrefutable facts and logic. The non-believer becomes “the other” that must be resisted if not fought (ironically) to the death.
.
The phenomenon is obviously most observed in the clash of religious beliefs due to closeness of those beliefs to explaining death. However, any worldview (say, economics) that is deeply-held can elicit a strong response because if one’s long-held worldview, shared with many many others, is wrong, then that raises the possibility you’ve been wrong about other constructs (e.g., your religious beliefs).
.
MMT is relatively a very very new economic thought taking on deep-seated economic beliefs that go back decades if not hundreds of years and discussed/reinforced among a huge array of people who hold the same construct from the barely educated to the those considered tops in their field (e.g., Nobel Prize winners). Moreover, MMT was not operational until after 1971, only 40 years ago. Why would we not expect the reactions that we often find? What was your reaction to it as it revealed itself to you?
.
Perhaps it is the answers to that last question that might help move the ball of recognition and, perhaps more-importantly, emotional acceptance further down the field. I do enjoy Rodger Malcolm Mitchell awarding dunce caps and Mike Norman’s logging the “smackdowns” I would guess old Chris Columbus had to shame some of his crew by questioning their sailing skills and bravery in order to get them comfortable with sailing to the edge of the world.
.
However, maybe old Chris also inspired some by revealing his initial doubts, if not intense rejection, of such a wild concept of a round earth and how he either overcame or at least managed his fears to consider the possibilities and the rewards.
.
Perhaps what would help is a new website or a section of one of the more-accessed websites dedicated to telling the many stories of the initial reaction if not repulsion and how that was eventually overcome. Perhaps seeing the cognitive dissonance and quick vitriol by those who once held similar views might help those now being confronted, confused, and lashing out. After all, you may not realize it, but you are threatening them with their eventual death.